Five Things to Avoid When Developing a Pricing Strategy
Pricing products and services appropriately is an ongoing business challenge. I’ve worked with a variety of clients from professional services firms to a technology start-up to a major retail bank to a national grocery chain on their pricing strategy and processes. Based on those experiences, here are five key things I’ve learned you need to avoid when developing a pricing strategy.
1. Don’t forget the customer – and don’t assume your customers think like you.
One of the biggest mistakes you can make is simply to base prices on your costs plus margin and what competitors charge. These are certainly useful data points that should be considered, but they are just the start of a pricing strategy. Prices must ultimately be driven by what your customers value and how that fits with the product and services you’re offering. Spend time understanding how they make purchasing decisions, what options they’ll really consider, how long it takes them to decide, what factors matter in their decisions, and what messaging will differentiate your product from your competitors.
Just look at the example of JC Penney under CEO Ron Johnson for what happens when you try to change prices without understanding your customers. In that case, JC Penney executives didn’t spend the time understanding that their customers loved coupons and searching for the best deal. When they went to a “no sales, no coupons” policy assuming that their customers would want this, customers left in droves – even though they were going to pay the same amount for products. The bargain hunting aspect of a trip to JC Penney had created a unique experience their core customers loved and removing that aspect of the shopping made the store a less attractive option.
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2. Don’t assume your customers really know what the price should be.
It's important to follow customer behavior and not only their opinions. Customers can be wrong about what they think they will do, especially for infrequent purchases where they don’t start out with a good sense of what a product should cost. Think about your latest trip to the grocery store – how many items do you actually remember the price of? For most people, it’s a handful of items they purchase almost every week – roughly four or five items; and that is for items that are purchased weekly in a price transparent environment. So take anything customers say about price with a hefty grain of salt. It’s not until they’re standing at the checkout counter or signing a contract that you really know if the price worked.
3. Don’t waste your time searching for the “perfect” price.
There is no such thing. Every single customer has a slightly different perception of the value of an item and the relative merits of different product characteristics – which can change over time. Short of implementing dynamic pricing exactly managed to each customer at the moment of decision (where customers never realize that others get different prices!), you’ll never get perfect pricing. If you can’t find a price that meets your margin requirements, the competitive environment, and customer needs, you have a product, operations, or messaging problem, not a price problem. Accept this, do your homework to set a reasonable pricing strategy, test your price strategy under the most realistic conditions you can manage, and move on, reevaluating as needed. There are other business areas that require attention, so don’t let your organization get bogged down in endless pricing debates.
4. Don’t expect your customers to be perfectly rational.
Behavioral economics have shown that customers (even B2B customers) are predictably irrational. Adjust your strategy to guide your customers’ behavior. For example, on average, people will select the middle option of “good, better, best.” Priming customers with higher priced options will make the middle option look like a bargain. Luxury fashion brands are the masters of this strategy. The $100 entry point on La Perla stockings looks far more reasonable when paired with a $700 item. They may not sell many of that $700 item, but it drives sales towards their other products. This is an area where you can run relatively low-risk pricing experiments. Understanding how these cues shape customer perceptions and behavior will help you refine your pricing strategy.
5. Don’t be unfair in your pricing – it’s not an effective long-term strategy.
Attempts to overcharge customers for the value they think they are receiving will eventually backfire. After living in the UK for a few years, I remember being shocked by how much more mattresses cost when I moved back to the United States. Since sleeping on the floor wasn’t an option, I grudgingly gave in and purchased one, but I was thrilled to have the chance to ditch it when new companies began to undercut the traditional manufacturers. If you’re using market power to push prices beyond a fair margin, someone will figure out what you’re doing, and your (rightfully) angry customers will be happy to leave. That doesn’t mean you can’t charge a good deal more than others – but customers must feel like they received a differentiated option that is worth the extra cost. In contrast to my mattress purchasing experience, my grocery bill has doubled since I moved closer to a Whole Foods, but I’m still delighted every time I leave the store. Their higher prices feel justified to me because I perceive their food as being higher quality. Aim to meet at a place of fair value for money with your customers over time.Pricing is an area that organizations can struggle with because there are so many possible options for how a pricing strategy can be developed and implemented, so many possible comparison points, and so many different decisions that need to be made. Setting a strong direction – whether that is high quality and expensive or every day affordability – can help guide pricing decisions and focus teams on the key tweaks to pricing that can provide incremental value. Ultimately, however, your customers are the only people who really matter in final pricing approval, and making sure you understand them inside and out is the key to an effective pricing strategy.